Saturday, September 27, 2008

The Bailout Is a Band-Aid

The Bailout Is a Band-Aid: Housing Crisis Needs to Be Fixed Thursday, September 25, 2008 4:18 PM

By: Christopher Ruddy www.newsmax.com

Yesterday Sen. Orrin Hatch was hitting the airwaves.

The subprime crisis, he said, was the fault of the Clinton administration, who he said created the subprime mortgage crisis.

Other Republicans have been laying blame on the financial crisis on minorities and illegal immigrants who got mortgages they simply couldn’t pay. They offer no statistical proof on this point.

Nor does the usually sensible Senator Hatch offer evidence when it comes to pointing the finger at the Clinton administration.

The attempt to deflect blame for the crisis is not simply wrongheaded; I think it will compound Republican political woes and bring us disaster again in November.

Doesn’t Hatch and Co. know that Bill and Hillary Clinton voters in the swing states will decide who becomes the next president? They are wary of Obama, but love the Clintons and remember the good economic times of the’90s.

As a conservative Republican of the Reagan type, I find myself in this odd place cheering on some of the sensible things I hear from Democrats.

Barack Obama said any bailout to Wall Street must not be simply a cash payout or a loan, but be treated like an equity investment in these firms. We want our money back and then some. Yes to that, I say.

And demands by House Democrats that the secretary of the treasury alone not be given a blank check for more than a trillion dollars of our money, and that we have complete transparency in the transactions, I say yes to that, too.

The Democratic complaints about the Bush plan shows that our government is working. The executive branch tried to put a gun to the head of Congress and told them, “Sign this check or the whole U.S. banking system will collapse.”

Congress didn’t blink.

Don’t get me wrong. I am for a bailout, but one that is sensible and is a win-win for Wall Street, Main Street investors and taxpayers like you and me.

But remember the government bailout plan proposed by the president and modifications supported by the Democrats won’t fix the underlying problem: the housing market collapse. Home prices are continuing to fall, and fewer people are buying homes than ever. Foreclosures will continue.

Unless this underlying problem is fixed, the economic symptoms will continue. There are some remedies. But before I get to them, let’s review what has happened.

The Federal Reserve under Alan Greenspan gave the U.S. economy shock treatment back in 2001 and 2002 when it lowered interest rates to 1 percent — the lowest Fed Funds rate in recent history.

By pushing the pedal to the metal and backed quietly by the White House, the Fed injected massive liquidity in the U.S. economy, creating the largest asset bubble in history, according to the Economist magazine.

Incredibly low rates by the Fed were accompanied by an acceptance of the central bank for all sorts of exotic mortgage loans. No down payments. Interest only. No job and income verification. Get the picture?

Compounding this irresponsibility was then the “greed factor” that kicked in at several levels.

First were the local banks and mortgage companies that pushed mortgages, notably adjustable rate ones that offered extremely low introductory rates, and gave them to buyers who would not be able to pay back once the rates adjusted up.

Well rates have adjusted up and the crisis hit.

Many mortgage providers also encouraged loan applicants to lie about incomes and qualifications to approve these mortgages.

Wall Street as a whole had little role at this stage. But later, Wall Street took these mortgages, which had been rolled up into collateralized debt instruments, better known as mortgage backed securities, and sold them off to investors globally.

Wall Street failed to compute the risks involved in these securities. It was a failure, not a crime.

But many Wall Street firms, hedge funds and other investments took incredible, unwarranted risks using these securities. These firms would borrow money at low rates — say 4 percent — and invest in CDOs paying 6 to 7 percent. This small difference in rates of 2 to 3 percent, the arbitrage, would throw off enormous returns, especially considering little or no money had been placed on the table to buy the securities.

I have been told that Lehman and AIG played this leveraging game, investing only $1 for every $30 they held in such toxic suggestions. Again, what they did was not a crime. They took enormous risk and reaped huge returns — for a while.

Now they want us to pay for the huge losses that ultimately fell upon them.

Washington played a role in the mess too. The White House pushed for easy money and easy lending practices, many weighted in favor of the banks and lenders and against the consumer.

Congress, dominated largely by Republicans from 1994 to 2006, did an awful job in oversight. This is especially true after President Bush took the oath of office.

When Bill Clinton was president, the Republicans acted beautifully, working diligently to keep President Clinton on a center-right economic course. The results were great.

This seems like ancient history, but it’s important to have a clear picture of how we got into this mess. It may help us get out of it.

First, we need to know the “crisis” the Bush administration presented to us just last week is not a crisis that just popped up. It was apparent to many two years ago the real estate market was in a bubble and would bust.

And when the Fed moved in 2004 and raised rates from 1 percent to 5.25 percent by 2006 — a more than 400 percent increase in two years, it also led directly to those adjustable mortgages re-adjusting at very high rates. Homeowners got struck hard — with monthly mortgage payments on medium size homes mushrooming literally overnight.

The Fed increase rates started the credit crisis. The first tremors were apparent over a year ago when the Fed took emergency steps to give banks liquidity.

It’s important to remember that most adjustable mortgages created in the boom years still have not reset – and will continue doing so through 2011.

This problem will worsen unless Washington tackled the underlying problems.

The first thing the Fed must do to reduce the continuance of the problem is drop rates. It doesn’t have much wiggle room, because the dollar needs to be protected, but a small decrease in rates could have an enormous impact on those readjusting mortgages.

The second-most-important thing to do is for Congress to give a significant tax credit for new home buyers. Congress just passed a $7500 tax credit for new home buyers, though it’s not actually a credit but a loan at no interest.

The famed economist Edward Leamer of UCLA’s Anderson School says a $25,000 tax credit to new home buyers would put an immediate end to the fall in home prices. He suggests it would spur economic activity and government tax revenues would grow, more than covering the cost of the program.

Already home prices have fallen to reasonable prices and it should be a buyer’s market. But government can spur home buyers who keep staying on the sidelines think prices will fall more.

If this is done, home prices will stabilize and likely begin rising. All of the sectors that relate to the housing market will find relief.

And, most important, the value of those mortgage backed securities will increase as the underlying mortgages become current. Foreclosures will also abate.

The key to solving the financial crisis is not to simply send a blank check to Wall Street, but to get consumers buying homes again.